December 14, 2010 Katie Behnke UW-Extension Agriculture Agent

Overview 12:30 – Overview of LGM-Dairy 1:00 – Join Webinar Overview of the cash and futures markets Overview of LGM-Dairy structure Review of actual and expected price determination Comparison of November and December contracts Use of LGM-Analyzer for historical analysis and monitoring future contracts Questions from attendees

Dairy Price Risk Management How can dairy producers control their milk price? Plant sponsored fixed price contracts Similar to a Class III hedge to lock in a price No upside potential Plant sponsored minimum price contracts Similar to a Class III put option Traditional hedging and options strategies Many alternatives – lock in a Class III price, establish a minimum price Contract lumpiness Margin calls with hedging

How can a producer establish a floor on Income over Feed Costs (IOFC)? Class III put options: Creates milk revenue floor Feed call options: Establishes feed cost ceiling Using this bundled option strategy, producer can establish an IOFC floor $/cwt Milk revenue floor Feed cost ceiling Minimum IOFC Dairy Revenue Risk Management

$/cwt IOFC IOFC * Class III Put Announced Class III ↑, → Don’t use Class III Put $/cwt IOFC Class III Put Feed Calls Feed Price ↓ → Don’t use Corn/SBM Calls IOFC * > IOFC IOFC * Dairy Revenue Risk Management

LGM-Dairy Overview Livestock Gross Margin Insurance for Dairy Insurance policy used to set an IOFC floor First contracts offered August 2008 Administered by the USDA Risk Management Agency and purchased from firms selling Federal crop insurance projects Similar to the use of bundled options, except LGM-Dairy has no minimum size limit Upper limit of 240,000 cwt over a 10 month period No actual futures market activity

LGM-Dairy Overview LGM-Dairy is customizable with respect to: Number of months insured 1-10 months Percent of IOFC (production) covered 0-100% of certified production each month Percentage covered can vary across months LGM-Dairy is available on the last business Friday of the month until 8:00 PM on Saturday

LGM-Dairy Overview Gross Margin Guarantee (GMG) = Expected value of milk – Expected feed cost – Declared Deductible Actual Gross Margin (AGM) = Actual value of milk – Actual feed cost Only one GMG and AGM per contract – evaluated over the entire contract period Indemnity (payout) occurs if AGM is less than GMG

CME SBM Futures Settle Prices Gross Margin Guarantee Actual Gross Margin Expected Gross Margin (IOFC) Deductible Level Expected Feed Cost CME Class III Futures Settle Prices Expected Milk Revenue Actual Feed Cost Actual Milk Revenue CME Final Corn, SBM Settle Prices Desired Coverage Premium & Subsidy Expected Feed Quantity Insurance Payout Producer Data/Decision Program Rules Market Data ? CME Final Class III Settle Prices CME Corn Futures Settle Prices

LGM-Dairy Overview Class III, corn, and soybean meal futures markets used as information source to determine Expected and Actual Prices No futures market transactions associated with LGM- Dairy Actual farm prices not used Once LGM-Dairy is purchased, the insured IOFC calculated cannot be lower than the GMG

LGM-Dairy Overview At sign-up, the producer declares milk production and feed equivalent to insure Producer defines Expected feed use in terms of corn (energy) and soybean meal (protein) equivalents Allowable declared feed equivalents: Corn: bu/cwt of milk Soybean Meal: lb/cwt of milk Program default values are: Corn=0.5 bu/cwt and SBM = 4.0lbs/cwt

Insurance Deductible Producer chooses the amount of gross margin not covered by insurance Deductible ranges from $0 to $2 (new!) Higher deductible Lower premium

Premium Based on the average of CME Group futures contract daily settlement prices Subsidy available Contract must be at least two months Subsidy is based on deductible Deductible = $0.00, Subsidy = 18% Deductible ≥ $1.10, Subsidy = 50% Due at the end of the contract period Previous analysis calculates the LGM-Dairy premium to be about half the cost of investing in a bundled options strategy (before the premium!)

Indemnity If total GMG > total AGM Indemnity paid If total GMG < total AGM No indemnity paid Market conditions are more favorable than existed at sign-up Higher Class III price, lower feed price, or both

LGM-Dairy Program Updates Changes take effect December 17, 2010 Premiums – now due at the end of the coverage period Higher deductibles – up to $2 Subsidy – A premium subsidy is available based upon the selected deductible level Adjustment of feed values

Questions?